A Growth Model of Inflation, Tax Evasion, and Financial Repression

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractIn this paper we study the effects of policies of financial repression on long term growth and try to explain why optimizing governments might want to repress the financial sector. We also explain why inflation may be negatively related to growth, even though it does not affect growth directly. We argue that the main reason why governments repress the financial sector is that this sector is the source of "easy" resources for the public budget. The source of revenue stemming from this intervention is modeled through the inflation tax. Our model has the implication . that financial development reduces money demand. Hence, if the government allows for financial development the inflation tax base, and the chance to collect seigniorage, is reduced. To the extent that the financial sector increases the efficiency of the allocation of savings to productive investment, the choice of the degree of financial development will have real effects on the saving and investment rate and on the growth rate of the economy.We show that in countries where tax evasion is large the government will · optimally choose to repress the financial sector in order to increase seigniorage taxation. This policy will then reduce the efficiency of the financial sector, increase the costs of intermediation, reduce the amount of investment and reduce the steady state rate of growth of the economy. Financial repression will therefore be associated with high tax evasion, low growth and high inflation. Before the 1970s, many economists favored policies of financial repression on several grounds. First, it was argued that. the government needed to impose anti-usury laws thereby intervening in the free determination of interest rates.Second, strict control and regulation of the banking system was said to give the monetary authorities a better control over the money supply. Third, it was thought that governments knew better than markets and private banks what the optimal allocation of savings was or what kind of investments were more or less desirable from a social perspective. Fourth, financial repression was identified with interest rates below market rates, which reduced the costs of servicing government debts.Some of the recent growth literature deals with the theoretical links between financial intermediation and growth along two lines:2 first, it analyzes how financial intermediation affects economic growth; second, it studies how economic gro...

Tax evasion and financial repression

“…Moreover, once we endogenize the process of tax evasion, it is likely that optimal policy decisions made by the government with regard to the policy instruments available, might vary depending on which factor is driving the change in the degree of evasion. This paper, thus, extends the work of Roubini and Sala-i-Martin (1995), Gupta (2005Gupta ( , 2006 and Holman and Neanidis (2006), by, first, providing the microeconomic foundations to the process of tax evasion, along the lines of Atolia (2003), Chen (2003) and Arana (2004), and second, by analyzing how a welfare maximizing social planner will respond to, in terms of its available policy choices, following an increase in the degree of tax evasion, and, in turn, can financial repression, measured by reserve requirements be motivated by tax evasion. To the best of our knowledge, such an attempt to rationalize financial repression based on endogenously determined tax evasion, is the first of its kind.…”

“…Changes in the degree of tax evasion, following a change in the tax rate, however reverses the sign of the correlation between tax evasion and financial repression. Recall, Roubini and Sala-i-Martin (1995) pointed out that governments subjected to large tax evasion will "choose to increase seigniorage by repressing the financial sector and increasing the inflation rates." In our case though, the first half of the result holds if the increase in the degree of tax evasion results from a lower penalty rate or higher level of corruption, i.e., lesser fraction of resources is needed to be spent to evade tax.…”

“…Both these studies suggested that, countries with an inefficient tax systems would be more oriented towards the repression of the financial sector. Roubini and Sala-i-Martin (1995) addresses this issue in a formal fashion, using an endogenous growth framework. They indicated that, governments subjected to large tax evasion will "choose to increase seigniorage by repressing the financial sector and increasing the inflation rates."…”

Does inequality cause inflation?: The political economy of inflation, taxation and government debt

“…The optimal revenue mix is tilted more towards seigniorage if the ruling political party has less of a dislike for inflation, if the costs of collecting taxes are high and the extent of tax evasion is widespread (cf. Canzoneri and Rogers, 1990), and if the financial system is relatively repressed (e.g., Roubini and Sala-i-Martin, 1992). Inflation will then be relatively high and income tax rates relatively low.…”

Anticipated policy and endogenous growth in a small open monetary economy

“…To clarify this, we follow Goldsmith (1969), Greenwood and Jovanovic (1990), King and Levine (1993), and Roubini and Sala-iMartin (1995) on the argument that more financial development (or a smaller degree of financial repression) stimulates economic growth by improving the efficiency of capital allocation. Then, in line with Pagano (1993) and Roubini and Sala-i-Martin (1995), we assume that a fraction f of real output is 'lost' in the process of financial intermediation as commissions, bank reserves, and so on. Moreover, Roubini andSala-i-Martin (1992, 1995) assert that f is affected by financial development (or financial repression).…”